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Last Christmas, I bought my son a pair of noise-canceling headphones. Now, even as I raise my voice to a shout, he can’t hear me above whatever is rattling around inside his head.

In short, he’s on his way to becoming the greatest investor of his generation.

Assault on the amygdala

The financial markets are a noisy spectacle. A generation ago, however, the noise was faint—a whisper from the stock tables in the daily newspaper or a weekly word of wisdom delivered in Louis Rukeyser’s baritone on public television.

Today, the noise comes at us in surround sound, the volume jacked up to 11. If we’re investing without high-end headgear, the 24/7 cycle of news and punditry can induce physiological effects that undermine our ability to stick with a long-term investment program.

“Deep in your brain, level with the top of your ears, lies a small, almond-shaped knob of tissue called the amygdala,” writes Jason Zweig in Your Money & Your Brain, an exploration of the neurological impulses that drive our investment decisions.

“When you confront a potential risk, this part of your reflexive brain acts as an alarm system—generating hot, fast emotions like fear and anger that it shoots up to the reflective brain like warning flares.¹

The same flood of hormones that prompted our forebears to flee from saber-toothed tigers can be activated by scary words and vivid images of risk. “A television broadcast from the floor of the stock exchange on a bad trading day, for example, combines a multitude of clues that can fire up the amygdala: flashing lights, clanging bells, hollering voices, alarming words, people gesturing wildly,” Zweig explains.²

Since the 2008–2009 financial crisis, we’ve heard a lot of hollering. Cash flow data suggest that the real traumas, and perhaps the uncertainty and speculation about what disaster might befall us next, have changed our behavior, making us less willing to assume risk. In 2006 and 2007, before the onset of the crisis, investors contributed a net $500 billion to stock mutual funds, including ETFs.

In the five years that followed, as headlines chronicled the collapse of Lehman Brothers, the European debt crisis, the U.S. debt-ceiling debacle, the prospect of a leap from the fiscal cliff, and other dangers, investors contributed less than one-third as much.

Source: Strategic Insight

Muting fear

How can we resist the impulse to act on fear? “Use your words,” Zweig writes. “[T]he more complex cues of language activate the prefrontal cortex and other areas of your reflective brain. By using words to counteract the stream of images the markets throw at you, you can put the hottest risks in cooler perspective. ³

When you feel compelled to change your investment behavior, ask yourself why. Have your goals and circumstances changed? Is the latest bad news so bad that it has radically changed the risks and returns associated with your chosen asset allocation? History suggests that, more often than not, the answer is no.

Andy Clarke

Andy Clarke helps lead Vanguard's Corporate Communications department.
Before joining Vanguard in 1997, Andy worked at Morningstar as an investment analyst. He is the author of Wealth of Experience, an introduction to investing based on ordinary people's stories about what has—and hasn't—worked as they've tried to meet their investment goals.
Andy holds a B.A. in English from Haverford College and is a CFA charterholder.

Comments

Paul D. | May 15, 2013 5:00 pm

Excellent and timely advice! I am glad I took a few minutes to re-read this article which has helped me get back ‘on course’. With the steady and seemingly relentless, daily drop in NAV of my bond funds recently, I was beginning to get cold feet for having taken the ‘bond plunge’ (even after understanding your excellent post “A Failure to Communicate”).

This article made me rethink why I originally diversified into bonds. None of the so called ‘pundits’ out there ever mention that you should give thought to WHY you decided to do what you did in the first place. It is better to recheck your goals in the clear light of reason, than in the fog of doubt and panic. Thanks for the voice of reason.

Becky T. | May 12, 2013 1:04 pm

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At Vanguard, we’ve always believed in candid, direct communication with investors. In fact, it’s one of our core principles. In 2009, we created the Vanguard Blog so that we could talk about what’s happening in our industry and in the economy—and hear what’s on the minds of investors like you. More

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Visit vanguard.com or contact your broker to obtain a Vanguard ETF or fund prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in Creation Unit aggregations. Instead, investors must buy or sell Vanguard ETF Shares in the secondary market with the assistance of a stockbroker. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss in a declining market.

Stocks of companies in emerging markets are generally more risky than stocks of companies in developed countries.

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.

All investing is subject to risk, including possible loss of principal.